Consider the following feature of two traded securities. Security A has an estimated volatility of its annual returns of 30%. It has a correlation with a large market portfolio of 0.36. Security B has an estimated volatility of its annual returns of 18%. It has a correlation with a large market portfolio of 0.85. The large market portfolio has an estimated volatility of its annual returns of 12%.

a. Assuming the current risk free rate is 2.5% and the expected annual return on the large market portfolio is 10%, determine the CAPM required returns for each of the securities.

b. A common conception in finance is more risk means more return. Does the security with the higher return volatility have the higher CAPM required return? If not, explain the rationale for risk return relation for these securities.

c. Suppose the two securities had a correlation between their returns of 0.05. Determine the volatility (standard deviation) of a portfolio of 50% security A and 50 % security B.